Vanguard won’t just come out and tell you that any of its funds aren’t top-notch. No fund company will — not when their goal is to sell you their products.
But I will.
I still think Vanguard is the best fund family around, but even the best isn’t perfect. Some of Vanguard’s funds are nurtured by expert managers and grow to be profit-building stars, but others are misguided, whether by poor managers or a fundamentally flawed investment strategy. These funds can doom your portfolio to mediocrity — or worse, major losses. And worst of all: Most investors don’t realize these funds are subpar until it’s too late.
I’d like to help you avoid that fate.
Investors should know the benefits and risks of all Vanguard funds, which I cover in great detail in The Independent Adviser for Vanguard Investors. But today, I’ve compiled a list of five of Vanguard’s wayward children that you can simply scratch off your list.
Some of these Vanguard funds are poor performers, some require too high of an ante and some have given way to better options. But in all cases, these funds just aren’t worth the warts.
Vanguard Funds No One Needs to Hold: Tax-Managed Small-Cap Fund (VTMSX)
By definition, the Vanguard Tax-Managed Small-Cap Fund (MUTF:VTMSX) is an actively managed fund. However, manager Michael Buek’s goal is to track the S&P SmallCap 600 index while avoiding any untoward capital gains, which makes VTMSX an index fund in my book.
For years, I was willing to hold my nose and said this fund might be worth owning over Vanguard Small-Cap Index (VSMAX) despite once-high minimums and back-end loads. Why? I preferred the S&P SmallCap 600 index.
However, Vanguard’s S&P series of ETFs — specifically, the Vanguard S&P Small-Cap 600 ETF (NYSEARCA:VIOO) — has made this tax-managed fund (and its siblings, for that matter) obsolete.
How long VTMSX sticks around is anyone’s guess, but it’s a has-been.
Vanguard Funds No One Needs to Hold: Precious Metals and Mining Fund (VGPMX)
A bull run in metals can make a fund like Vanguard Precious Metals and Mining Fund (MUTF:VGPMX) look very attractive. To wit, thanks to double-digit gains by the likes of Goldcorp Inc. (USA) (NYSE:GG) and Royal Gold, Inc (USA) (NASDAQ:RGLD), VGPMX is up more than 10% less than a month into 2015.
But when the going gets rough, investors should watch out below.
Precious Metals and Mining’s cumulative loss ran to nearly 70% in 2008, and it still hasn’t recovered. As mining companies continue to merge without regard to the best interest of shareholders, diversification is increasingly difficult. Considering the huge risks associated with this sector, the fund is only for speculators, not investors. And even speculators shouldn’t allocate more than 5% of their portfolio to it.
Worsening the fund’s situation further, its longtime manager, Graham French, handed the reins to recently promoted co-manager Randeep Somel in November 2013. Somel has his work cut out for him here, as VGPMX would need to gain nearly 200% from here for investors who got in at that 2008 peak to be made whole.
Vanguard Funds No One Needs to Hold: Long-Term Treasury Fund (VUSTX)
The higher yield of long-term funds can be tempting, but it comes with a price: higher risk. With an average maturity around 25 years, Vanguard Long-Term Treasury Fund (MUTF:VUSTX) carries more than twice the risk of intermediate-term funds, and the yield (30-day SEC yield of 2.25% currently) isn’t much better.
Also, remember that while the Federal Reserve’s moves affect short-term rates, inflation typically impacts long-term rates. If inflation were to roar back, VUSTX could suffer.
For my part, I’d rather stay shorter and safer than try to catch a few more points of yield and be sorry for it.
Vanguard Funds No One Needs to Hold: Market Neutral Fund (VMNFX)
I wouldn’t spend too much time on Vanguard Market Neutral Fund (MUTF:VMNFX). This fund is unique to Vanguard’s lineup, but its utility is limited.
Market Neutral has been around since November 1998, but Vanguard only entered the picture when it “adopted” it in November 2007, and appointed its quant group as a co-manager alongside the original manager from AXA Rosenberg. In August 2010, Vanguard fired AXA, and it has held the reins solo since.
The aim is to keep risk low while generating small, regular gains — regardless of the direction of the stock market. Vanguard’s quant group aims to achieve this lofty goal by matching “long” holdings against “short” positions.
How have they done? Since Vanguard took over, the fund has lagged Vanguard 500 Index Fund (MUTF:VFINX) by a wide margin, about 20% to 115%. That’s no surprise when stocks have been on such a big upward run and “safe” investing is bound to come up short. Yes, Market Neutral does look better relative to Vanguard Prime Money Market Fund (MUTF:VMMXX), which is up only 0.1% over the same period, and Vanguard Short-Term Treasury Fund (MUTF:VFISX), which gained 3.2%. But it hasn’t quite been all smooth sailing, as Market Neutral lost 1.5% in 2012.
This uninspiring record coupled with the $250,000 minimum has kept investors away — only about $310 million is currently invested in the fund. Vanguard recently dropped the minimum hurdle on the fund to $0 for those investors working with financial advisers, but for most investors, this fund’s role is played in Vanguard Managed Payout Investor (MUTF:VPGDX), which allocates a roughly 10% weight to Market Neutral.
Even if you can meet the investment hurdle, I’d watch this one from the sidelines.
Vanguard Funds No One Needs to Hold: Extended Market Index (VEXMX)
“You complete me?” Not quite.
Vanguard Extended Market Index Fund (MUTF:VEXMX) is a “completion” index, meaning that when it is combined in a portfolio with 500 Index, it essentially gives you the entire market of U.S. stocks. Extended Market Index used to track the Wilshire 4500 index, which included all of the stocks in the Wilshire 5000 index less the 500 stocks in the S&P 500. Now, however, it tracks something called the S&P Completion Index.
I struggle to see where this fund fits in. If you want to own the entire U.S. stock market, why not just hold Vanguard Total Stock Market Fund (MUTF:VTSMX) and be done with it? And if you want mid-cap stocks, then just buy a mid-cap index. With more than 3,000 stocks in its portfolio, this is really a “smid-cap” (small-cap plus mid-cap) index that Vanguard has lumped in with the mid-caps.
For my money, I want to control how much I have invested in large caps versus mid- and small caps. Well, you can do that with various Vanguard index funds, and for mid-caps, Vanguard MidCap Index Fund (MUTF:VIMSX) is a great choice. Despite the fact that Extended Market offers exposure to small stocks, which are supposedly the better performers, MidCap Index has outperformed by just over 2% per annum since its inception.
If it’s mid-caps you want, I’d stick with MidCap Index.
Daniel P. Wiener is editor of The Independent Adviser for Vanguard Investors, a monthly newsletter that keeps abreast of recent developments at Vanguard, and the annual FFSA Independent Guide to the Vanguard Funds.